If Cyprus can dip into people’s private savings, how safe are we?

Cyprus bailout: How safe are our people's bank deposits?

Cyprus is a tiny island nation with an economy to match but the government’s plan announced over the weekend to dip into the bank deposits of its citizens in a “one-off” move to help pay for a bailout has sent a tremor through global markets.

The country’s shocking move to charge depositors a bank levy could open up a ‘nasty can of worms,’ analysts fear could trigger a run on banks in other EU countries. Continue reading.

Cyprus is admittedly an unusual case due to the extent of its difficulties and the large proportion of offshore depositors. But the question is, if Cyprus can do this, what about other countries?

According to Moody’s, it’s time to start worrying.

“Even if the risks of contagion in this case are limited… the decision to impose losses on depositors signals euro area policymakers’ willingness to risk triggering wider financial market disruption in pursuit of other policy goals,” the rating agency said in a report Monday.

In other words, the cat is out of the bag.

“We continue to monitor the situation in Cyprus, which remains fluid,” said Kathleen Perchaluk, spokeswoman for Jim Flaherty, the Canadian Finance Minister. “It is important that the Europeans take the necessary steps to deal with sovereign debt issues while securing financial stability. The situation highlights the importance of Europe advancing efforts on a full banking union, which they have been making progress on.”

Given the extent of off-shore business at Cyprus’s banks, it’s likely that plenty of Canadians have already been caught up in the mess.

“This is insane,” said Noel Biderman, the Toronto-based founder of a popular Internet dating business. “The purpose of a bank from my perspective is to help you protect your assets, not come in and seize them.”

Mr. Biderman recently decided to set up an office in Cyprus, partly to cater to the new markets but also to hold the company’s major assets including intellectual property. Less than a year later, the Cypriot government seems set to hit his company with a tax, which he sees as a penalty for choosing the country as a place run his operations and create jobs.

Under a controversial deal struck with the International Monetary Fund and other foreign lenders, a 6.65% levy would be placed on all deposits less than 100,000 euros with a corresponding 9.9% for those exceeding that amount, to raise about 6-billion euros for the government.

Cyprus has long been a thorn in the side of countries like Germany and France who worry that its tax haven laws provide protection for vast amounts of ill-gotten wealth from Russia, China and other jurisdictions.

Indeed, some observers say this bail-out was structured for eurozone policymakers to make it palatable to voters in Northern Europe who don’t want to be seen to be rescuing a group of off-shore depositors from countries such as Russia, which accounts for about 30% of all Cyprus bank deposits.

Vladamir Putin, the Russian president, slammed the proposed levy, calling it “unfair, unprofessional and dangerous.” Meanwhile, the Russian finance minister hinted that Moscow could call a 2.3-billion euro loan made to Cyprus two years ago.

The purpose of a bank from my perspective is to help you protect your assets, not come in and seize them

Another concern among its larger euro neighbours is the enormous size of Cyprus’s banking sector, nearly eight times the size of the country’s GDP, versus a eurozone average of about half that.

“I think the message [from bailout lenders] was pretty loud and clear,” said BMO chief economist Doug Porter. “They were only willing to bail out the domestic portion of Cyprus’s needs and the country had to find another way to plug the hole [for the foreign depositors]. They were simply not willing to write a bank cheque.”

In the face of growing public unrest, the country’s minority government on Monday delayed an emergency vote on the matter until Tuesday. For fear of a run on the banks, branches remain closed and automated teller machines were either closed or empty as frightened Cypriots tried to withdraw what savings they had ahead of the tax.

What’s especially alarming about the levy is that it’s the first time since the start of the European crisis that governments have talked about forcing depositors to cover the cost of a bailout. Ideally, it’s the bond holders and shareholders who end up shouldering the pain even though in practice it’s been taxpayers. But forcing depositors to take the losses strikes at the core of the financial system, delivering a blow to public faith that their savings will be protected.

Experts say Canadians have little to fear they could ever face a similar penalty, given the strength of the Canadian banking system and the relative strength of the Canadian economy.

“The World Economic Forum has ranked Canada’s banks as the soundest in the world for five years in a row and Canadians have confidence that their deposits are safe and sound,” said Rachel Swiednicki, a spokeswoman for the Canadian Bankers Association.